It stemmed from one of his readers asking if printing that much money would cause hyperinflation. Mish has been one of the few steady deflationists over the past few years. His definition of inflation is an increase in the money supply and credit. Deflation is a decrease in the money supply plus credit. My definition is the same so we can have an apples to apples discussion here.

The problem that the Fed has faced in generating inflation is that we have a massive debt overhand that has built up over the past 40 years. When debts become too large a burden they default and the total debt/credit market decreases in size. This has a re-enforcing downward cycle on bank reserves which impact their ability to lend (grow credit) even further. The credit market in the United States grew from $1 trillion to over $50 trillion in 2008, and since then it has trended sideways and slowly risen due to massive government spending offsetting consumers deleveraging (paying down and defaulting on debt).

To complete the full scope of this discussion it must be looked at through a worldly lens as there are no borders today with capital flow. To understand how $50 trillion created by the Fed would impact the price of gasoline and food in America, you must look at currency and debt creation around the world vs. debt defaults and money contraction. I am going to table that part of the discussion today in order to help make it easier to understand. We'll just focus on the United States and pretend it is a closed economy (although I promise to take this thought process global in near future for those that want more).

Let's look at both pieces of the equation before we get started. The first is liquid cash, in which we have the Fed's M2 money supply to use as a barometer. This number just recently crossed $10 trillion.

Then we have credit. The following chart shows the most recent release from the Fed on total credit, crossing upward into new highs. We'll call this number $54 trillion (what's a few hundred billion in debt among friends right?). Total credit is composed of consumer loans (credit cards, student loans, auto loans, and mortgages), government debt (treasury bonds), corporate debt (corporate bonds), and debt from the banking sector.

The last one, the banking sector, is where Mish focuses most of his attention during discussions on inflation. This is again correct as the banking sector is the most important of the four. Why? Because money is loaned into existence. I do not have the time here to explain this concept, but for those that would like a primer see What Is A Ponzi Scheme?

In 2007 the banking sector found itself loaded with residential and commercial real estate loans. Prices began to collapse on the assets behind this debt (real estate) making their portfolios underwater due to the significant amount of leverage they utilized on their balance sheets.

To counter this problem the Fed began QE1 which focused on purchasing mortgages and treasuries from banks in exchange for fresh cash. This lowered their leverage and began to alleviate the pain on their balance sheets. Due to the fact that banks were still underwater, they were taking the cash and parking it, not lending it out as they were before 2007 (this process is still taking place today). The following shows excess reserves at the banks as this new cash continues to be hoarded.

Why is this money not inflationary? Imagine that the Fed prints a trillion dollars and brings it to your home. You take the cash and put it in your garage and close the door. This is not inflationary because the money has not entered the economy. No prices are pushed higher with the cash just sitting in your garage, just as prices are not pushed higher with the money just sitting on bank's balance sheets.

So with this foundation in place we can go back to the original question: Would the Fed printing $50 trillion tomorrow create hyperinflation?

To answer this you must first think about what the Fed would purchase with this money. As a quick primer - the Fed creates money electronically by purchasing an item in the economy that is already in existence in exchange for cash. Imagine you have $1,000 in bonds in your portfolio. The Fed would pay you $1,000 in cash and take your bonds. You then have $1,000 in liquid cash to do with what you like (unlike the bonds which required you to sell in order to spend the money). This is how QE works and how the money supply is expanded (see m2 and bank reserve charts above).

So what would the Fed purchase with $50 trillion? So far they have purchased only mortgage bonds and treasury bonds. The entire debt of the United States government has just crossed $16 trillion. This means they have issued a total of $16 trillion in treasury bonds. The Fed already owns $1.65 trillion of this outstanding amount leaving a remaining $14.35 trillion in treasury bonds they could purchase.

There is currently about $13 trillion in total mortgage debt. The Fed already owns $850 billion in mortgages leaving about $12 trillion in available mortgage debt the Fed could purchase.

This means if the Fed purchased every available treasury and every mortgage bond around the world it would use up about $26 trillion of their available $50 trillion available to spend. That leaves $24 trillion to go.

At this point Mish does not think this $26 trillion in fresh cash now sitting available would create hyperinflation. His reasoning is correct in that most of it would be sitting as bank reserves that could only enter the economy as liquid currency through lending. However, we know that if banks felt their balance sheets were whole with most their debts liquidated then they could put this money to work in other areas such as commodities through their trading units instead of holding 100% of it in cash (sitting in the parking garage). Hold that thought, we'll come back to that in a second.

As a quick side note, I understand that this does not account for the shadow banking market. I will cover that as well in another discussion in the near future.

In his 2002 "helicopter drop" speech, where he promised to drop money from helicopters if needed, Bernanke provided multiple strategies for fighting deflation. The first three in the speech we have already experienced:

1. Lowering interest rates to zero
2. Buying treasuries and mortgages through QE programs
3. Providing long term "guidance" on rates (he has promised to keep rates at zero through 2014)

There is a fourth strategy that he discussed that is usually never mentioned. It can be considered the "nuclear" option. If the first three strategies did not work Bernanke said the Fed could begin to purchase assets outside of treasuries and real estate debt. This could be municipal bonds, commercial real estate, student loans, credit card debt, auto loans, stocks, gold, or your neighbor's fishing boat. The Fed could essentially wipe away the entire debt owed in the United States with a simple keystroke.

This debt is not exclusively owned by banks. The Fed would have to provide cash to insurance companies, pension funds, and every day people in the United States. Mish's argument is that the entire country, sitting on this $50 trillion in cash earning 0% which has been promised through 2014, would simply put it in their garage and never touch it.

He feels no one would buy stocks and more importantly they would not buy commodities such as oil, agriculture, copper, silver, or aluminum. If even a tiny fraction of that $50 trillion in fresh cash were to move into commodities it would create an unimaginable price spike which would in turn lead to a super surge in the cost of living.

To say that $50 trillion printed tomorrow would not create a hyperinflationary scenario is a silly statement. The next question, the one that is more important; what is the amount of printed currency (the magic number between $3 and $50 trillion) that would create a runaway inflation type scenario? That is what we will look at in part two of this discussion.

Thursday, August 30, 2012

As the following info graphic shows, Apple recently become the largest company in world history, eclipsing Microsoft's peak in 1999.
Maybe its because I do not own an iPhone or iPad, but it seems to me that a company that bases 72% of its revenue off just those items would be susceptible to competitive forces taking away from their market share. This is unlike Microsoft in 1999 who had a monopoly on their software in every PC sent out around the world.
I certainly would not want to own it, but I definitely don't have the courage to short it. Here are the details on the largest that ever was:
h/t Pronto.com

Long time friend of this website, Peter Schiff, took some time to speak with Fox Business this week about politics.

It was surprisingly one of the more fair interviews from the mainstream media where a voice of the free market was actually allowed to speak for a few sentences without being cut off and asked why he wants to cut spending which will "kill little children" and "put old sick people out on the street to die." For those quotes you can listen to 99.9% of the rest of mainstream media discussion, but for something a little different, the truth, here is a breath of fresh air.

Wednesday, August 29, 2012

The entire world is speculating on a small set of words Bernanke will speak this week in Jackson Hole. While this has not been an important week in the past, Bernanke decided to use this forum to announce QE2 and Operation Twist during 2010 and 2011, which has now turned the venue into a rock concert for the financial markets. It is incredible that the world has come to this, but there is no doubting the power of Bernanke's words and actions.

Bill Gross, manager of the largest bond fund in the world, discusses what he sees coming from Jackson Hole, the ECB, and how it will impact the markets moving forward.

While stocks tread higher based on hopes of new money printing, economists are shocked that this does not carry over into the confidence of the consumer. I explained why late last week in Economic Growth Mirage.

"We should be careful to get out of an experience only the wisdom that is in it and stop there lest we be like the cat that sits down on a hot stove lid. She will never sit down on a hot stove lid again and but she will never sit down on a cold one either."

- Mark Twain

"It's waiting that helps you as an investor, and a lot of people just can't stand to wait."

- Charlie Munger

"Live as if you were to die tomorrow. Learn as if you were to live forever."

- Gandhi

"One of the best rules anybody can learn about investing is to do nothing, absolutely nothing, unless there is something to do. I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up. I wait for a situation that is like the proverbial shooting fish in a barrel."

- Jim Rogers

"Capitalism without financial failure is not capitalism at all, but a kind of socialism for the rich."

- James Grant

"At this juncture, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained."

- Ben Bernanke, March 2007

"Everything that needs to be said has already been said. But since no one was listening, everything must be said again."

- Andre Gide

"When people are getting richer and richer but they're not actually producing anything, it can't end well."

- Louis CK

"In economics things take longer to happen than you think they will, and then they happen faster than you thought they could."

- Rudiger Dornbusch

"I don't write about what I know. I write to find out what I know."

- Patricia Hampl

"Chains of habit are too light to be felt until they are too heavy to be broken."

- Warren Buffett

"Everyone has a plan until they get punched in the mouth."

- Mike Tyson

"Interest on the debt grows without rain."

- Yiddish Proverb

"You can have comfort, or you can have value. You cannot have both."

- Jim Grant

"Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful."

- Warren Buffett

"No very deep knowledge of economics is usually needed for grasping the immediate effects of a measure; but the task of economics is to foretell the remoter effects, and so to allow us to avoid such acts as attempt to remedy a present ill by sowing the seeds of a much greater ill for the future."

- Ludwig von Mises

"Men who can both be right and sit tight are uncommon."

- Jesse Livermore

There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.

-Ludwig von Mises

"Most investors think quality, as opposed to price, is the determinant of whether something's risky. But high quality assets can be risky, and low quality assets can be safe. It's just a matter of the price paid for them."

- Howard Marks

"Whenever you find yourself on the side of the majority, it is time to pause and reflect."

-Mark Twain

"None are more hopelessly enslaved than those that falsely believe they are free."

-Goethe

"The longer the markets disobey basic rules of valuation, the bigger the opportunity for good investors to reap the benefits. Value investing works precisely because markets become dysfunctional at times."

-John Coumarianos

Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.

-Sir John Templeton

"No very deep knowledge of economics is usually needed for grasping the immediate effects of a measure; but the task of economics is to foretell the remoter effects, and so to allow us to avoid such acts as attempt to remedy a present ill by sowing the seeds of a much greater ill for the future."

- Ludwig von Mises

"People only accept change in necessity and see necessity only in crisis."

-Jean Monnet

Requiring a central bank to print money to increase government's purchasing power invariably ignites a hyperinflationary firestorm. The result through history has been toppled governments and severe threats to societal stability.

- Alan Greenspan

"It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning."

- Henry Ford

"Do you want to sell sugared water for the rest of your life? Or do you want to come with me and change the world?"

-Steve Jobs

"I'd be a bum on the street with a tin cup if the markets were always efficient."

-Warren Buffett

"The market can stay irrational longer than the investor can stay solvent."

- Keynes

"While the government struggles to save one crumbling enterprise at the expense of the crumbling of another, it accelerates the process of juggling debts, switching losses, piling loans on loans, mortgaging the future and the future's future. As things grow worse, the government protects itself not by contracting this process, but by expanding it."

-Ayn Rand, 1974

"The test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function."

- F. Scott Fitzgerald

"All our life, so far as it has definite form, is but a mass of habits - practical, emotional, and intellectual - systemically organized for our weal or woe, and bearing us irresistibly toward our destiny, whatever the latter may be."

-William James

"Men it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one."

-Charles Mackay

The greatest enemy of knowledge is not ignorance, it is the illusion of knowledge.

- Stephen Hawkings

"Give me control of a nations money supply, and I care not who makes it's laws."

- Amschel Rothchild

Illusions commend themselves to us because they save us pain and allow us to enjoy pleasure instead. We must therefore accept it without complaint when they sometimes collide with a bit of reality against which they are dashed to pieces.

- Sigmund Freud

Many of life's failures are people who did not realize how close they were to success when they gave up.